Sean Carney (Dow Jones Newswire 14.6.2007)
A spike in long-term interest rates in the U.S. and Europe in recent days highlights the vulnerability of the Czech koruna and may lead to capital temporarily fleeing the region, a member of the Czech central bank's Monetary Policy Committee said.
"Capital will react to available yields, and for the economies of Central Europe, capital can start to move to territories where interest is rising," Pavel Rezabek told Dow Jones Newswires in an interview Wednesday.
"In and of itself this can have an influence on other economies and the koruna," he said. "A negative influence."
Longer-term interest rates have risen sharply this week and last in both the U.S. and euro-zone markets. That gives investors in emerging markets the chance to shift capital to lower-risk areas with higher yields. It may also cause developed economies to slow, weakening demand for products made in Central and Eastern Europe.
The Czech Republic has the lowest interest rates in the European Union, with the central bank's main policy rate set at 2.75%, and 10-year yields running at 4.56%.
Yields on U.S. 10-year Treasury debt are now 5.22%, while the German 10-year bund offers 4.65%.
Mobile capital is exiting the market. Currencies around the region, including the Romanian Leu and the Slovakian koruna, have weakened over the last few days, with the Czech koruna hitting a nine-month low against the euro Wednesday at 28.56.
The koruna further weakened Thursday, trading at 28.625 versus the euro at midday.
Volumes on the Prague Stock Exchange have been lower than average since last week's surge in U.S. yields, while the auction Wednesday by the Czech Finance Ministry of a new 15-year bond was a flop, with little interest, according to local traders.
The Finance Ministry targeted 7 billion koruna ($326 million) for the auction, yet only received bids worth CZK4.995 billion. By contrast, the June 6 auction of 10-year benchmark bonds recorded CZK23.56 billion in bids received.
Yield Differentials Widen
"The Czech koruna at the moment is at a weaker level (than before) and it doesn't correlate to the level of economic growth of the Czech Republic," Rezabek said.
The Czech case is a miniature version of Japan, where the yen is sliding against the euro and dollar although the economy is growing faster than in the euro area or the U.S. Czech gross domestic product expanded at an annualized 6.1% rate in the first quarter.
U.S. bond yields tracked back down somewhat Thursday, but Central European currencies remained weak. Some analysts are advising investors to stay on the sidelines with these currencies as long as upward risks to U.S. yields persist.
Rezabek noted that markets tend to assess the Czech economy along with neighboring countries, which have had over the last 12 months some of the world's fastest appreciating currencies.
But the Czech koruna's appreciation halted in March, roughly at the time the European Central Bank raised its policy rate to 3.75% from 3.5%. The ECB raised the rate to 4.0% last week.
The Czech central bank raised its main rate in May to 2.75% from 2.5%. The yield differential between the Czech koruna and the euro is now 125 basis points, more than the 50 to 100 basis points average gap present in much of 2006.
Central banks in neighboring countries have higher rates, measuring 4.25% in Poland and Slovakia, 7.25% in Romania and 8.0% in Hungary.
But Rezabek says he doesn't think the yield differential alone - known as the "carry" among traders - plays such a significant role in regional currency developments.
He said he believes the Czech koruna will return to its long-term appreciating trend.
Monetary Policy Is Too Strict
In the wake of higher-than-expected producer and consumer price inflation in May, analysts expect the central bankers to raise interest rates as soon as July. But Rezabek said he prefers not to rush to raise rates prematurely, which could lead to having to cut them again in the not-too-distant future.
"I am against unnecessarily strict monetary policy," while the central bank is maintaining price stability and often inflation is undershooting the bank's target, he said. Tighter monetary policy has a negative effect on the economy rather than a positive one, he said.
Overly strict monetary policy in the past has resulted in annual inflation below the central bank's target of 3% every year for the last five years, he said.
Czech inflation is currently running at 2.4% in May from 2.5% in April.
Czech monetary policy has been "stricter than was necessary," he said, adding that while the key role of the central bank is to maintain price stability, it also should support economic policy.
Rezabek described himself as neither a dove nor hawk but rather an owl and says it's important to focus on prudence. Both the past and the future warrant careful evaluation, he said.
"There are seven individuals (on the MPC) and each presents his reasoning, and there is no reason why at the end we should all have the same opinion," he said, adding that more varied opinions enable better decisions.